The Dodd-Frank financial reform act signed this month by President Obama was, in my reading, very unfriendly to the non-agency MBS market. Taken in its entirety, key provisions of the bill create significant and protracted uncertainty for issuers and investors, further delaying the much-anticipated revival of private-label MBS issuance.
There was no surprise that a risk-retention clause was contained in the package, as some form of the provision has been in virtually all proposals. However, many critical details have been left to regulatory bodies to define and implement over time. For example, the definition of "qualified residential mortgages" exempt from risk retention will be jointly defined in the future by a collection of regulators. In addition, both the SEC and the FDIC have proposed comprehensive sets of rules that include different provisions for risk retention; the bill calls for them to be reconciled within 270 days and implemented in another year. While this represents the "fast track" for regulators, issuers will contend with major uncertainty until next spring.
Another provision exposes the rating agencies to legal liability if their ratings are included in new-issue registration statements. As a result, the rating agencies stopped allowing their ratings to be included in new bond offering documents, causing the SEC to waive the requirement that the documents include credit ratings for six months.
While the focus of attention has been on ABS issuance, the rule also may affect the issuance of non-agency MBS. Private-label MBS deals have historically been structured with subordination levels assigned by the rating agencies, and the various tranches are typically listed with their rating in the prospectus supplement. In my view, the rating agencies are intrinsic to the process of creating non-agency MBS transactions. While Congress's desire to restore accountability to the rating process is understandable, this provision arguably requires a complete revamping of the process by which deals are structured and marketed.
There is also the potential for conflicts resulting from the bill's provisions establishing procedures for the "orderly liquidation" of large, systemically important financial institutions. The problem is that securitizations are created in "bankruptcy-remote entities" that ensure that the assets backing a deal are not ensnared in a bankruptcy proceeding. Analysis by the law firm Sidley Austin noted that there are potential conflicts between bankruptcy law and the bill's new resolution authority. In my mind, it's quite unclear how a structure that is isolated from the new liquidation authority would be constructed while still allowing for sale treatment of the assets. This is particularly the case in light of FAS 166/167 restrictions on off-balance-sheet financing and further complicated by the risk-retention requirements for loans that don't qualify for exemption.
Irrespective of the merits of any single provision, the legislation as a whole creates layers of uncertainty for all participants in the private-label MBS markets. The effect will be to push the renewal of robust volumes of publicly registered non-agency transactions well into the future.
Finally, the legislation has been criticized for its failure to address the future of the GSEs. I have no problem with deferring GSE reform, since their problems are so large and complex that they merit a separate debate. However, I'd argue that by effectively impeding the renewal of non-agency MBS issuance, this legislation limits the degree to which Freddie and Fannie can be restructured in the future. Because housing finance will remain almost completely reliant on government-sponsored securitization, substantive changes to the GSEs would be extremely disruptive to housing and the economy. Whatever the intent of the Act's authors, the bill entrenches the GSEs' dominant role in the mortgage and real estate markets.
Bill Berliner is a mortgage and capital markets consultant based in Southern California. His Web site is www.berlinerconsulting.net.